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Shadow banking

Shadow banking

The most significant remaining FSB concern relates to collective investment vehicles that are susceptible to runs.

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The FSB assessment (PDF 929 KB) observes that a combination of regulatory measures and de-risking by (some) financial institutions has reduced considerably the financial stability risks posed by the shadow banking activities that contributed to the financial crisis. This includes most types of structured finance, banks’ use of special purpose vehicles, and the liquidity and maturity mismatches in money market funds. As a result, the shadow banking sector is generally less leveraged.

Elsewhere, however, risks to financial stability remain significant and in some cases are still growing. Here the FSB highlights:

  1. The size and considerable growth of collective investment vehicles that are susceptible to runs, such as open-ended fixed income funds, credit hedge funds, real estate funds and MMFs, accompanied by a combination of a relatively high degree of credit risk and maturity transformation. This could lead to significant disruptions in the event of market stress.
  2. Although non-bank financial entities (mostly finance companies) that are dependent on short-term funding to support lending activities have declined since the crisis to 8% of shadow banking assets, these entities tend to have relatively high leverage and to engage in some maturity transformation, which makes them more susceptible to roll-over risk, including during period of market stress.
  3. Similarly, although market intermediaries (such as broker-dealers) dependent on short-term funding experienced a sharp decline after the financial crisis, these intermediaries comprise over 11% of shadow banking assets, engage in significant leverage and maturity transformation, and in some cases have a relatively high level of interconnectedness with other sectors of the financial system.

In response, the FSB notes the importance of the effective implementation of the FSB’s January 2017 policy recommendations to address structural vulnerabilities from asset management activities. The International Organisation of Securities Commissions (IOSCO) is consulting on liquidity risk management in investment funds, and is looking to develop consistent leverage measures by the end of 2018.

Otherwise the FSB does not identify the need for any additional regulatory action at global level to deal with financial stability risks from shadow banking, although it does recommend some enhancements and strengthening of data collection and oversight.

FS Regulatory Insights: August 2017

FS Regulatory Insights: August 2017

Updates are coming from the European regulators on a seemingly daily basis.

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